Question

Select the correct answer. A price floor will usually shift: a. demand b. supply c. both d. neither Illustrate your answer with a diagram.

Short answer

The correct answer is (d) neither. A price floor does not shift the demand or supply curves. Instead, it affects the quantity supplied and demanded in the market. When a price floor is set above the equilibrium price, sellers want to sell more at the higher price (moving along the supply curve), while buyers want to buy less (moving along the demand curve). This creates a surplus in the market. In a diagram with price on the vertical axis and quantity on the horizontal axis, the price floor appears as a horizontal line above the equilibrium price, but the supply and demand curves do not shift.

Step-by-step solution

Understanding the concept of price floors

A price floor is the legal minimum price that can be charged for a particular good or service. This is set by the government or another regulatory body, and sellers are not allowed to charge a price lower than this limit.

Understanding the Demand and Supply curves

In economic theory, the demand and supply curves represent the behavior of buyers and sellers in the market. The demand curve shows the quantity that buyers are willing to purchase at different prices, while the supply curve shows the quantity that sellers are willing to sell at different prices. The price in an unrestricted market typically settles at an equilibrium point where the quantity demanded equals the quantity supplied.

Explaining the impact of price floors.

When a price floor is set above the equilibrium price, it doesn't shift the demand or the supply curves -- those remain the same as before the price floor was instituted. However, what changes is the Quantity Supplied and Quantity Demanded. Specifically, sellers want to sell more at the higher price (moving along the supply curve to a higher quantity), but buyers want to buy less (moving along the demand curve to a lower quantity). So the imposition of a price floor leads to an excess of supply, also known as a surplus.

Answering the Multiple Choice Question

Given this understanding, the correct answer is: d. neither

Drawing the diagram

The diagram would have Price on the vertical axis and Quantity on horizontal axis. Draw descending demand curve and ascending supply curve, intersecting at Equilibrium point (E). Price floor is a horizontal line above this equilibrium price. The intersection points with Supply and Demand curves above and below this line represent the Quantity Supplied and Quantity Demanded respectively after the imposition of the price floor. This shows clearly the excess supply or surplus resulting from the price floor - but crucially, the Demand and Supply curves themselves have not shifted.